Gotta Give ‘Em Credit

G

I don’t normally make a habit of clicking on the obnoxious ads at the bottom of articles. I actually try and make sure to never visit any ad that is contextualized via either Facebook or the ever ubiquitous tentacles of The Google.

However, today I couldn’t help but click through to what I assumed would be something ridiculous, an ad for an article entitled Top 3 Reasons to Get A New Credit Card.

And needless to say, I was not disappointed.

I would normally consider myself to be the last person anyone should turn to for financial advice, given my (fortunately now) historic ambivalence towards all things financial. But the whole notion of this ‘article’ was simply begging for a response, and as I am sucker for the ridiculous, I was more than happy to oblige.

A Boy and His Computer (And the Credit Card In Between)

I think I have only used a credit card once in my entire life. I’m not sure that I had strong feelings one way or another towards them (see my previous financial ambivalence), but I was always inclined to only buy something if I actually had the money in hand to pay for it. This was obviously much easier before debit cards became more prevalent, since I often would go to look at things to buy without actually having any money; ergo, I could not buy them. This actually helped me to be a bit more discriminating in my purchases, since the intervening time between seeing an item and rounding up the cash to purchase it was akin to the proverbial cold shower, meaning that 9 times out of 10 I would ultimately forgo the purchase altogether.

However, when I was 25 I found myself in the position of needing to purchase a rather pricey item (a computer) and not having the cash on hand with which to buy it. To be fair, that wasn’t actually true. I did in fact have the money; it was just that the purchase would deplete about 50% of all the money I had at that time. I happened to be in between jobs and thus needed to be as scrupulous with my purchases as possible.

At this point the discerning reader may be asking: Um, if you needed to conserve cash, why were you contemplating the acquisition of a $3200 computer? An insightful question! (And, by the way, how did you know how much it cost?) I was just launching into my blossoming career as a designer/animator, and had a project lined up but with no computer with which to do it. Fortunately, however, the project in question was going to pay enough to cover the cost of my computer. In my mind it all added up; now the only question was how to pay for it.

Instead of negotiating a portion of the payment up front or simply paying for it in cash, I decided (for whatever reason) that it would be a better idea to pay for it with a credit card. My reasoning, as far as I can remember, was that since the money was going to be coming in in short order after completing the project, if I paid with a credit card I wouldn’t be out any cash up front and everything would work out with no consequences or problems. So instead of taking the less risky approach and paying for the computer in full with cash, I took out my first credit card and worked my plan.

Fortunately for me. everything worked out. I completed the project and got paid within the specified time period. However, even though I now had the money and could pay off the card per my plan, I started to consider how it would be a shame to part with all that money right away. After all, I would be getting a job soon (hopefully!), and then I could (obviously!) pay back bigger chunks once I had a regular income. With such brilliant reasoning I decided to keep the debt around a little bit longer, first one month, then two, then three. At the end of the third month I finally came to my senses, like the prodigal longing for the husks of the swine in the mud, and bit the bullet and paid it off. True, it didn’t end up being that big of a deal in the long run, but I still ended up paying more than I would have had to, despite my plans and best intentions.

The dutiful reader may once again with astounding prescience suspect that this personal anecdote is serving as some sort of meaningful segue into a larger point. And that reader would, of course be right.

As I think back to the whole situation I remember thinking initially that I had essentially gamed the system. True, I ended up paying a bit more in interest than I had planned to, but I essentially got out of it with little to no consequences and a new computer. Brilliant strategy, right? At the time I certainly thought so. But while hindsight is rarely 20/20, it is almost infallibly painful and filled with regret, especially as we realize the mistakes we have made and the dangers we so narrowly avoided.

After further thought, reflection and an eventually greater interest in all things financial, I finally realized that I was not playing the system but was rather being played by the system. Consider the following: At the time I was unemployed, had little to no monthly income, and had student loan debt I was still repaying. By any reasonable measure I was not someone who should have been loaned more money since I had very little money, already owed lots of money and wasn’t getting any money on a regular basis. Yet a credit card company is ‘willing’ to loan me up to $5000 in spite of all this.

On a rational level it simply doesn’t make sense until one realizes that people in debt are actually the perfect marks, er, customers for credit card companies since they are the people most likely to spend money they don’t have since they have a track record of already doing so.

Once I realized this I looked back on that period of my life with a little bit of terror. My ‘plan’ at the time was a best-case scenario with no meaningful Plan B. Consider this: I had no job at the time, and the purchase I was making constituted around half of all the money I had. What if I wasn’t able for whatever reason to finish the project and get paid? What if the client was for whatever reason unable to pay? A thousand other things could have happened and my plan would have been shot to hell, leaving me standing with outstanding debt on over half of my savings, no fund for emergencies and no income to replenish it.

I have always fancied myself someone who thinks things through, but these are thoughts that never once occurred to me. I was so naive and irresponsible and basically got lucky that everything actually worked out.

I’m not sure if I closed the credit card account immediately after I finished paying it, but I don’t think I ever used the card again. Now it is with amusement that I see credit card offers which pour into my mailbox with unfailing regularity, promising this reward or this benefit, yet somehow never mentioning that life happens, things go wrong, and you can be left with a huge debt and an outrageous interest rate.

We all know credit card debt is a pretty big problem, but yet we are constantly bombarded with the product on every side. Every NCAA Tournament I am greatly entertained by having Sir Charles tell me how great it is to use a Capitol One Visa on everything from dinner to concessions at a basketball game. The trademarked question “What’s In Your Wallet?” could probably be well answered by “Certainly Not Any Money.”

But since credit card debt is such a big problem the credit card companies have to find more creative ways to induce us to borrow from them at exorbitant interest rates. The most common methods nowadays are the ubiquitous ‘rewards’ programs that each card offers. We all know the drill- cash back on X amount of purchases, X% back on groceries, airline miles, etc. From a purely objective point of view it’s really quite absurd; we agree to borrow X amount of money at a ridiculous interest rate for the promise of equally ridiculously small rewards.

You Gotta Spend Money To Make Less Money

Coming back to the article, let’s see how Next Advisor sells the Top 3 Reasons to Get A New Credit Card.

#1. EARN REWARDS FASTER THAN YOUR CURRENT CREDIT CARD
It’s likely you haven’t been paying much attention to how your current credit card rewards you for making purchases. In fact, many so-called “reward” cards have tricky formulas, limits on the amounts you can earn and rules that require you to sign up for special quarterly rewards. Oftentimes what looks like a good deal can leave you earning much less than you could with a better card.

So, the BEST reason to get a new credit card (i.e., borrow money from a credit card company at a terrible interest rate) is to earn rewards faster? Really? One might be led to believe that these rewards must be pretty amazing to get someone to borrow money at such terrible rates.

One would be wrong.

If you like to travel, snap this card up. The Barclay Arrival Plus World Elite Mastercard offers 2 miles per dollar spent on ALL purchases and a juicy 40,000 bonus miles after spending $3,000 in the first 3 months (equal to $400 in travel). Add to that no foreign transaction fees and you’ve got yourself a great rewards card. There is a $89 annual fee that is waived the first year, but most people will earn enough rewards by using the card to more than make up for it.

Travel miles are of course a popular piece of bait incentive for credit cards, since it often seems that one is getting the opportunity to travel somewhere for free, or at least to be able to “save money” on a trip. It can almost seem like one is getting the credit card company to pay for one to travel, especially if one tries to “game” the system by paying off the card every month.

Here’s the reality: of course credit card companies want you to travel because most people spend more money while they are traveling than they do when they are at home. When you travel you generally need a place to stay, you often eat out more than you normally would, miscellaneous travel expenses, tourist traps, etc. And what are you more inclined to pay with when you travel? A credit card. After all, who wants to carry a bunch of cash while traveling? Additionally, the notion that one has a ‘free’ trip with credit card reward miles might compel one to take a trip that one otherwise might not, significantly raising the possibility that one is going to spend more money than one might have without the rewards, and that money has a much higher likelihood of being spent with- you guessed it!- a credit card.

While credit card companies make money on interest from balances that linger, they also get a percentage of sales when that card is used. Thus, every time you purchase something with a credit card that company takes a portion of it. As such, even if you managed to travel for nothing other than the travel fees that the credit card rewards paid for, you would not actually be ‘playing’ the system since they get paid either way. It is in their best interest for you to use your card as much as possible, so of course they are going to entice you with little bonuses like travel miles which you may or may not even use.

This offer might seem wonderful at first glance, but the fine print should be noted. True, you receive 40,000(!) bonus miles after spending $3000 in the first 90 days, which is equivalent to a $400 credit. However, you only get 2X miles for every dollar spent after that, which means one would presumably have to spend $20,000 to get another $400 in travel credit.

Let that sink in. You spend $20,000. You get $400. Actually, it’s not even $400 in cash since you have to spend it on travel.

But maybe this one is just a fluke, and there are better rewards cards out there. There have to be, right?

If cash back rewards are more your speed, this card is a humdinger. Users will earn 3% cash back on gas and 2% cash back at grocery stores for up to $1,500 in combined gas and grocery purchases each quarter. They’ll also earn 1% cash back on all other purchases. And there’s a generous $100 cash rewards bonus after spending $500 in the first 90 days as well as a 0% intro APR for 12 billing cycles on purchase and balance transfers.

Seriously, this is Next Advisor’s #1 Pick for a cash-back credit card. But let’s run the numbers.

Firstly, you get 3% back on groceries and 2% back on gas up to $1500 per quarter. So even if all you purchased was groceries the most you could get back per quarter is $45. Seriously, $45! That’s $180 a year.

But wait, you might say, what about that $100 cash back bonus for spending $500 in the first 90 days? Ok, we’re up to $280 a year (even though you are out $500…). But wait again, you implore, what about that 1% cash back on all purchases? Let’s assume you had a $5000 limit that you spent every month and repaid. You would spend $60,000 a year, which at 1% cash back would ‘earn’ you $600, which brings us to a grand total of $880.

Granted, if someone wanted to give me $880 I wouldn’t object, but if $60,000 comprises your grocery, gas and other discretionary expenditures per year, $880 is simply not a game-changer in any meaningful sense. Let’s assume the $60,000 represents 60% of the total income for the year, with a total of a $100,000 income. That $880 would constitute less than ONE PERCENT of one’s yearly income. And in this scenario you have to spend at least $60,000 to ‘earn’ less than $1000. The numbers will actually work the same for just about any income level, with the important caveat that if your income/outgo ratio is worse you will technically get more cash back in relation to your income, although that will also mean that on the whole you retain less money so as to receive more cash back.

Because that makes sense…

Of course, the rub of the whole matter with both of these #1 rewards card is that they carry ridiculous interests rates. The BankAmericard has a variable rate of 12.99%-22.99%! In other words, if for whatever reason you are not able to carry out your plan of paying off the card every month, you could be stuck with an interest rate that is nearly equal to a quarter of the balance.

Losing Is Really Saving, Right?

#2: SAVE LOTS OF MONEY BY PAYING $0 INTEREST FOR 18 MONTHS

Need to make a big purchase or purchases but can’t pay them off right away? Or already paying interest on a credit card balance? The fiscally wise thing to do is to get a card that offers a NO interest period so you can pay down the balance without paying any fees. These cards are basically equivalent to an interest-free loan, and will save you a ton of money.

Actually, the fiscally wise thing to do is to not purchase something unless you actually have the money to pay for it… Interestingly, Next Advisor speaks the truth in that these credit cards are basically like taking out a loan.

However, there is this misnomer about how they will “save you a ton of money.” How, exactly, does that work? What Next Advisor doesn’t tell you is that using a credit card generally makes people more likely to purchase things they wouldn’t otherwise buy, both because of the promise of no-interest for X amount of time and the rewards. But more fundamentally, paying by means of plastic bypasses the normal pain that comes from the use of a physical object such as cash. As I mentioned in my anecdote, before I had a debit card I could only buy something if I had the cash. This gave me more opportunity to consider a purchase and determine whether or not I really wanted or needed the item. Paying with plastic (especially credit cards) obviates this time for reflection and makes impulse purchasing effortless and painless, which is precisely what credit card companies want.

The catch is this: sure, the ‘smart’ (*snicker*) thing to do would be to pay off the entire balance each month and avoid the interest fees. However, if you have 18 months(!) of interest free payments, what does it hurt to let it hang around a little bit? Surely there are more productive things that could be done with that money… The problem becomes immediately obvious when one runs the numbers.

Assuming someone had $5000 on their balance with an APR of 16%, if they paid $125 each month (!) they would need nearly 5 years to pay off the balance, and in the process would run up about $2000 in interest payments. True, with 18 months of interest free payments the total interest amount would be less, but let’s assume they still pay $125 a month. At the end of the 18 months they would have only paid off $2250 of the balance and would then have to begin paying interest on the remaining balance.

These types of statistics are the kinds of things that credit card companies know and are banking on. So of course they will give you a seemingly long period of time with no interest since they understand that statistically most people will not pay off their balance before the interest-free period ends.

Astonishingly, the savings of paying 14-22% interest on $2750 as opposed to $5000 is the “ton of money” that is ‘saved’ according to Next Advisor. Fair enough, the numbers work out to paying $521 in interest as opposed to $2000. But this is only ‘saving lots of money’ in an extremely superficial sense since one ultimately is paying more for the item than if one had paid for it in cash. It would actually be better stated as ‘losing less money.’

***UPDATE***

My friend Jeremy pointed out that in most cases after the ‘interest free’ period the interest that should have accrued is actually charged on the balance all at once. So the only way in which would actually ‘save money’ (read: lose less money) in this scenario would be to pay off the entirety of the balance before the interest free period ends. As mentioned earlier, the statistics are not your friend when it comes down to the likelihood of this actually happening.

If You Didn’t Have Debt You Couldn’t Get More Debt, Duh…

#3: IMPROVE YOUR CREDIT SCORE

Whether you’re new to the world of credit or just want to improve your credit score, getting another credit card can help. That’s because another credit card will add to the total amount of revolving credit you have and help your credit utilization ratio. This ratio is basically just how much credit you have compared to how much of that credit you’re using. So if you have $10,000 in credit available and are using $5,000 of it your credit utilization ratio is 50%. Now if you get another credit card with $5,000 in credit your total credit will increase to $15,000, bringing your credit utilization ratio down to 33%. Since up to 30% of your credit score is based on whether you’ve maxed out your total credit line, getting another credit card can assist in improving your score. Just remember not to get too many new credit cards at one time as that might appear as if you need credit, potentially causing your credit score to dip.

I know that the commercials with the guy playing guitar and singing about getting a free credit report are pretty amazing and emotionally moving (*rolls eyes*), but the difficulty with having a good credit score is that a credit score is essentially an indication of how much debt you are carrying, have carried and are likely to carry and pay back. One will actually have a better FICO score by continually carrying some debt (and of course paying off enough to not damage the score).

The difficulty with always carrying some debt, however, is that debt is a financial burden/liability and represents risk. As I related in my opening anecdote, I was on the hook for nearly half(!) of my savings. Sure, I had a ‘plan’ that I hoped would work out (and, fortunately for me, did), but there were so many uncontrollable variables that could have landed me very quickly in a very bad place.

That does not even take into account the amount of stress I remember experiencing as a result of knowing this was hanging over my head. Even though paying the credit card off was painful in that I had to part with a rather sizable chunk of money, it was actually very freeing since I knew that I no longer had this weight burdening me. And why should I? I already had the student loan debt to do that!

Uggghhhh….

Ultimately, the problem with credit cards (and really all debt) is that it places one into a position of great risk in which a multitude of variables are unknown and which make any given liability even greater and riskier. Let’s face it, life happens and things rarely work out exactly as we anticipate. Adding needless financial risk to one’s life is a miserable way to live, especially when the crap hits the fan (which it will at one time or another).

And yet we tend to rush headlong into the gaping maw of the credit card companies, all the while thinking we are blessed to have been generically pre-approved for a higher limit, a lower interest rate or a better paltry reward.

You gotta given ‘em credit, because they are more than willing to give it to you.

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Jason Watson

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